An operating budget is a financial plan that outlines an organizations expected revenue and expenses for a specified period. It is a detailed projection of what a company expects its revenue and expenses will be over a period of time. Operating budgets are usually formulated near the end of the year to show expected activity during the following year. An operating budget helps organizations set and achieve business goals by providing a reference point for all activities over the next twelve months.
An operating budget contains the revenue and expenditure generated from the daily business functions of the company. It concentrates on the operating expenditures, such as the cost of goods sold (COGS), the cost of direct labor and direct materials that are tied to production, as well as the overhead and administration costs tied directly to manufacturing the goods and providing services. The operating budget will not contain capital expenditures and long-term loans, which are part of capital budgeting.
The more detailed an operating budget is, the more relevant and valuable it becomes. An operating budget may include a high-level summary along with several supporting sub-budgets that provide greater detail. The most common components of an operating budget are revenue, variable costs, fixed costs, and non-operating expenses. Revenue shows the several ways an organization generates money by offering services or selling goods. Variable costs are costs that are directly related to a businesss main activity. Fixed costs are costs that are not directly related to a businesss main activity. Non-operating expenses are those that fall below Earnings Before Interest and Taxes (EBIT) or Operating Income.
Creating an operating budget is a collaborative effort involving executives and managers. First, they must estimate the coming years revenue by checking the firms historical performance and then considering market variables that may affect revenue. Then, they must estimate the costs of goods sold, variable costs, fixed costs, and non-operating expenses. An operating budget doesnt have to be an annual endeavor and can be reviewed monthly or quarterly. Reviewing and revising the operating budget is important, as there will always be unexpected expenses that impact the forecast.
